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-A person’s house is part of her: wealth-A person’s checking deposits are part of her: $-Money is: (a) anything that is generally accepted in payment for goods & services or in the repayment of debt. (b) frequently – but incorrectly) used synonymously with wealth (c) paper $, coins & checks-True statement: The conversion of a barter economy to one that uses $ increases efficiency by reducing transaction costs. -Ranking assets from most liquid to least: currency; bonds; house.-A fall in the level of prices: increases the value of money- The 2 most important parts of the narrowest monetary aggregate (M1) are: checkable deposits at banks & currency in the hands of the public.-If nominal GDP is $10 trillion, & Ms is $2 trillion, velocity is :5- According to Quantity Theory of Money, if the quantity of $ doubles, prices will double. - A statement, such as “velocity falls as fears mount of Increased Risk in Financial Markets,” means: the public’s demand for many has increased as a result of increased uncertainty.-An increase in velocity is synonymous with: a decrease in the public’s desire to hold $ - Using the dynamic version of the equation of exchange, if M increases by 5% but Velocity falls by 5%, assuming prices are inflexible, the rate of real GDP growth will be: 0% - A credit money system is one in which: the liabilities (IOU’s) of private financial institutions serve as the major medium of exchange. -An individual who arranges for buyers & sellers to exchange securities & earns a commission in return is a: broker-Newly issued stocks & bonds are bought & sold in: primary markets. -The higher market liquidity is, the narrower the bid- asked spread will be. -Efficient capital market theory suggests that: the more accurate info investors have, the more efficient financial markets will -Which are strongly implied by efficient capital markets theory? (a) the price of a share immediately incorporates new publicly available info that affects its value. (b) on average, investors who carefully select stocks in which to invest will earn no more than the market rate of return, which is what one could earn if one selected a portfolio of stocks at random. - Risk aversion implies that: investors must be compensated for the risk they take on.-Evidence that most investors are risk averse is that they: buy a diversified portfolio.- If asset A is a 30- year US Treasury bond yielding 9% & asset B is a 30- year corporate issued by GM that also yields 9%, risk averse investors would: prefer Asset A -The most fundamental proposition of modern portfolio theory is that: even though an asset is risky in isolation, when combined with other assets the risk of the portfolio is less, perhaps even 0.-If asset returns are less than perfectly correlated, portfolio diversificiation: reduces nonsystematic risk.-A venture capital fund wants to invest $1000 in each of one thoughsand mad scientists. The 1st scientist applying to the fund is working on the legendary pill that turns water into gasoline, and the 2nd scientist is working on the even more legendary perpetural motion machine. The smart venture capitalists here will: back the pill, the machine & 998 other projects.- The US Gov’t securities market determines yields that serve as a practical reference point for all other securities market. -A good purchase for an investor seeking a high degree of liquidity with minimal market risk would be a U.S.: T-Bill-Recent US budget deficits have been financed by forgeigners; if it weren’t for foreign PURCHASES of Treasury securities, US interest rate would be muchHIGHER.-Under the IMF fixed exchange rate system, a nation running a balance of payments deficit would have an excess SUPPLY OF its currency in the foreign exchange market & that nation’s central bank would have to SELL foreign exchange to maintain the fixed exchange rate. -Fed Funds rates: int. rate that banks charge each other for overnight loans -Eurodollar market is an alternative way for BANKS to lend or borrow.-The rate at which banks borrow directly from the Fed is: the discount rate. -Which of the following usually has the highest yield at a given point in time: corporate bonds -If an issuer has the right to pay off a bond before its maturity, the bond is: callable. -Mood’s gives junk bonds rating below: Baa.-CDO’s: mortgage loans that have been scrutinized .-Suppose the yield on the gov’t bonds falls. This should cause a fall in the discount factor in the stock price valuation formula & a rise in the stock prices.-An increase in the perceived risks of a corporation’s stock raises the discount rate in the stock price valuation models and lowers stock prices.-A deficit in the balance of payments means that we are paying out moe $ abroad then we are taking in, resulting in an appreciation of foreign exchange relative to the $. -A deficit in our balance of payments causes the dollar to depreciate, which causes the deficit to decrease. -The equilibrium price for a British pound is $1.60. At a price of $1.55 per British pound, there would be excess supply of the dollar and the dollar would depreciate.-If the inflation rate increases in the US, everything else constant, the dollar depreciates against the yen and the yen appreciates against the dollar.-When the Fed lowers interest rates in the UD relative to those in the U, we would expect: the $ to depreciate & the pound to appreciate. -Under the IMF fixed exchange rate system, a nation running a balance of payments deficit would have an excess supply of its currency in the foreign exchange market and that nation’s central bank would have to buy some of its currency to maintain the fixed exchange rate.-A nation running a persistent balance of payments deficit while part of a fixed exchange rate system would have to pay out; international reserves in an effort to prevent its currency from depreciating. -Why would anyone buy a bond with default risk when they could purchase defailt risk free bonds? b/c investors are compensated for assuming more default side with higher interest rates. Which of the following stocks is most expensive, from the standpoint of financial theory? A stock selling for $25/ share with P/ E ration of 50/1 .If a person bough a put option on IBM stock with a strike price of $45 and the stock is selling for $40 on the expiration date the option would be worth: $5. If you alone epect the U.S. int. rate to rise relative to the Euro interest rate, and your expectations turn out to be true, you could make a future in the futures market by: selling Euro futures. Suppose the manager of a coporation receives 1 million call options on his company’s stock with a strike price of $20. On the day that his option expire, his company’s stock is trading at $18/ share. If he sold his options: his compensation would not change. Financial intermediaries are specialists in the production of: info. Bank capital = total assets – total liabilities. A bank is insolvent when: liabilities > assets. Holding large amounts of bank capital helps prevent bank failures b/c: it can be used to absorb the losses resulting from a decrease in the value of the bank’s assets. For a given return on assets, the lower is bank capital: the higher is the return for the owners of the bank. In the absence of regulation, banks would probably hold: too little capital & take too much risk. Bruc the Bank Manager can reduce int rate risk by shortening the duration of the bank’s assets to increase their rate sensitivity or alternatively, lengthening the duration fo the bank’s liabilities. – Increases in a bank’s capital requirements are meant to: decrease the likelihood of bank failure by making it less likely that banks will make too many high risky loans. – A bank can reduce its credit risk by: holding more diversified loan portfolio. –Financial markets quickly eliminate profit opportunities through changes in :asset prices. – Sometimes one observes that the price of a company’s stock falls after the announcement of favorable earnings; consistent with the efficient marets hypothesis if the earnings were not as high as anticipated. Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets hypothesis: useless, and a waste of time. The major function of bank reserves is to serve as a source of: liquidity. A fractional reserve banking system is one in which banks only keep a fraction of their liabilities on hand in form of cash. Under a 100% reserve banking system banks would only be able to make loans up to the amount of their capital which would greatly reduce the money supply’s ability to grow in response to increased economic activity. If a company’s stock has a P/E ratio of 20 & net earnings per share are expected to remain constant for the foreseeable future is it a good value when the interest rate on bonds of similar risk is 10%? Why or why not? The internal rate of return on the stock is 5% given it’s current PE ration, which is lower than the interest rate. Therefore the stock is a bad value relative to the bond (1/ P/E ration= internal rate of return) Interest rate parity condition: iD= if – (eet+1 – eT) *eet+1 =expected future exchange rate 1 yr from now *eT= current spot interest rate eT
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